Finally, Manmohan Unleashes Animal Spirit Icing on the cake: RBI may cut key rates Slow Growth, Lower Deficit Hopes To Spur Move

NewDelhi:After a barrage of policy initiatives from the government, the Reserve Bank of India is likely to top it up with a reduction in interest rates on Monday, when it reviews monetary policy. 

    The move is expected despite inflation jumping to 7.55% in August from 6.87% in the previous month and some food items displaying a stubborn rising trend. The view in political circles is that the central bank is widely expected to sustain the "feel good" moment with an interest rate cut. 
    India Inc has also mounted huge pressure on policymakers demanding a moderation in the tight policy. "The party is not over yet. RBI is also going to announce a set of measures on Monday," a senior government official said without elaborating. 
    Although the government's move to raise diesel price and let companies fix the price of cooking gas on a monthly basis is expected to impact inflation, the first round effect on inflation is estimated to be 60 basis points (100 basis points equal one percentage point). 
    "The government has taken measures to control the fiscal deficit through both a diesel price hike and by announcing disinvestment. Now that there is a path to fiscal consolidation, the monetary policy needs to be conducive to growth through a cut in the cash reserve ratio," said Shikha Sharma, MD & CEO of Axis Bank. 
    "On rates, despite inflation likely to remain well above RBI's medium term target of 4-5%, we are holding on to our 50 basis points rate cut call in the second half of 2012-13 due to the deceleration in growth. While the fuel inflation internals provide no justification for easing in its September 17 policy, its worth keeping in mind that similar to past moves, the RBI could justify monetary action referring to government action on the fuel price front and to any possible measures on FDI/ divestment," Citi economist Rohini Malkani said in a note. 
    Bank of America Merrill Lynch India economist Indranil Sengupta too sounded optimistic about a possible rate cut on Monday and predicted a 25 basis points reduction by RBI. Economists suggested that the fuel price hike and the renewed push on disinvestment will lower the pressure on the fiscal deficit, prompting the central bank to come out of the pause mode. 
    Growth has slowed to 5.5% in the April-June quarter while industrial growth has collapsed. Investment has slowed and policymakers said there was a need to revive growth. The government has opened the reform floodgates and there is an overwhelming feeling that the central bank too should play its role in accelerating growth. 
    Sources said the government has taken bold steps to repair its finances and trim subsidies despite a tough political environment. RBI has been repeatedly urging the government to take steps to devise a credible fiscal consolidation plan which would help it ease rates. 
    Finance minister P Chidambaram has spoken about the need to take "calibrated risks" on rates to cushion the consumers reeling under the burden of high monthly loan installments. The government is also keen to lift the mood of consumers ahead of the festive season starting late October. 
    Economists said the sharp increase in diesel prices and the cap on subsidized cooking gas cylinders has sent out a strong signal that the government is keen to clear the fiscal mess. Several economists said that the bold government moves provides enough elbow room for the central bank to change its hawkish stance.